Colombia surprises with a hike to 12.25% on a 4-2-1 vote, keeping an 8.25-point cushion over the Fed

Colombia's central bank, Banco de la República, raised its benchmark rate by a quarter point to 12.25% on Wednesday, ending a pause that had held the rate at 12% since July. Four board members voted for the increase, two wanted no change and one pushed for a half-point rise, according to Portafolio and El Tiempo. Bloomberg called it a surprise move.

It was. In a Citi survey of 23 institutions cited by The Rio Times before the meeting, 18 expected the rate to stay at 12%.

Why the bank moved

Inflation turned back up. Annual inflation was 6.2% in August against a 3% target, with food at 6.1%, regulated prices at 6.8%, services at 7.2% and core inflation at 6.1%, the highest in a year, Portafolio reported. Analysts surveyed in September raised their forecast for December inflation to 6.8%, which means the market expects it to get worse before it gets better, although two-year expectations eased to 4.0%.

The bank also pointed to the risk that El Niño pushes food and regulated prices higher, and to tighter international financial conditions. Colombia One reported that governor Leonardo Villar said cuts would not be considered until inflation is clearly under control and falling. The growth picture is mixed: second-quarter GDP grew 3.4% from a year earlier, but July's economic activity index rose only 1.1% and manufacturing shrank 2.3%, according to Portafolio.

The number that matters for currency traders

The Fed's own hike on September 16 put its target range at 3.75% to 4%, according to the FOMC statement. Measured against the top of that range, Colombia now pays 8.25 points more, up from 8 points before Wednesday. Mexico, by contrast, held at 6.5%, leaving a cushion of just 2.5 points.

Adjusted for inflation the gap is still wide. Colombia's 12.25% minus 6.2% inflation leaves a real rate of about 6 points. The Fed's 4% ceiling minus core PCE of 3.0% leaves about 1 point. That spread is what makes the Colombian peso a carry trade, where investors borrow in a low-yielding currency to hold a high-yielding one, and why a surprise hike can support it.

The peso needed support. The Rio Times reported the official rate at 3,349.63 per dollar on Tuesday, the weakest since early July, after the dollar gained about 9% in two weeks, though the peso was still stronger than a year earlier. The board's minutes are due October 5, the paper said.

Who it hits

For US companies that buy from or sell into Colombia, the direct effect runs through the exchange rate, and the reaction on Thursday is what to watch. For Colombian borrowers, credit just got more expensive again at a time when factory output is already shrinking.

Sources: Portafolio; El Tiempo; Bloomberg; The Rio Times; Colombia One; Federal Reserve. This is market information, not investment advice.